Introduction

Hedge funds are similar to private equity funds and mutual funds in that they are pooled investment vehicles. Hedge funds were originally designed to invest in equity securities and use leverage and short selling to “hedge” the portfolio’s exposure to movements of the equity markets. These types of funds are prohibited, in most countries, from marketing to non-accredited investors. The funds originally were designed for a small number of large investors, and the manager of the fund received a percentage of the profits earned by the fund.

Hedge
Hedge fund business really picked up in the 1990s, fueled mainly by new wealth generated during the 1990s equity bull market. Hedge funds typically issue securities in private offerings that are not registered with the SEC under the Securities Act of 1933. Hedge funds can, and do, employ a wide range of strategies. Hedge funds have been attracting bucket loads of institutional money, a phenomenon that most likely will continue to mushroom. Hedge funds are the new mutual funds. But they still represent a small portion of the world’s markets (mutual funds, in contrast, have assets totaling much more). Hedge funds benefit by heavily weighting hedge fund managers remuneration towards performance incentives, thus attracting the best brains in the investment business. Hedge fund managers are generally highly professional, disciplined and diligent. Managers are active managers seeking absolute return. Hedge funds often take large risks on speculative strategies, including program trading, selling short, swap, and arbitrage and their manages are fiercely protective of their trading strategies. Hedge fund strategies vary enormously — many hedge against downturns in the markets — especially important today with volatility and anticipation of corrections in overheated stock markets. Hedge funds make money from finding and exploiting tiny efficiencies, by piling into obscure undervalued stocks, or by building up stakes in weak companies that can be prodded and put up for auction. Hedge funds typically charge an asset management fee of 1-2% of assets, plus a “performance fee” of 20% of a hedge fund’s profits.

The presumption is that hedge funds are pursuing more risky strategies, which may or may not be true depending on the fund, and that the ability to invest in these funds should be restricted to wealthier investors who are presumed to be more sophisticated and who have the financial reserves to absorb a possible loss. Hedge funds, private pools of capital limited in most cases by law to no more than 100 investors, but are no longer the exclusive stomping grounds of the rich and famous. An important point is that hedge fund investors do not receive all of the federal and state law protections that commonly apply to most registered investments. Investors may be unable to determine the value of their investment at any given time as well. Hedge funds provide an ideal long-term investment solution, eliminating the need to correctly time entry and exit from markets. These funds may have an aura of exoticism and modernism, but their goals are as old as the art of investing itself.

Conclusion

Keeping in mind that not all hedge funds are the same, any investor can probably find a strategy within the hedge fund universe that best suits his risk profile and investment style. Given the future investment environment for hedge fund investing and the high cost of hedge fund investments, hedge funds are unlikely to cumulatively outperform the stock market in the coming year. But hedge funds are now a major force in the global financial markets.